Thrift Savings Plan participants have access to one of the world’s most cost-effective retirement plans. This is more important than many investors realize. Over time, lower investment costs can add tens of thousands of dollars to your retirement account balance compared to paying higher investment expenses. The SEC has an excellent PDF that explains the importance of investment fees.
Unfortunately, many companies attempt to take advantage of Veterans and civil service employees by trying to convince them to transfer their Thrift Savings Plan funds into more expensive investments. These higher investment fees separate TSP members from their hard-earned money while putting more money into advisors’ pockets.
That isn’t to say all financial advisors are trying to pull one over on you, or that you should never roll your money out of the TSP. The key is knowing when you may be better off leaving your investments in the TSP, and knowing when it makes sense to transfer your investments into an IRA, another qualified retirement account or an annuity. Our goal is to help you understand some of these differences. Please keep in mind that this is general information. You may wish to seek professional guidance for your specific situation.
When to Consider Leaving Your Investments in the TSP
In many cases, transferring your funds out of the TSP simply isn’t necessary. The TSP has enough investment options to fully diversify an investment portfolio, and the low expenses can put more money in your pocket.
How much will low fees actually save you? A white paper from Morningstar, an investment research company, listed the average expense ratio for all mutual funds in 2014 as 1.19 percent (this was most recent data available). That means investors paid $1,190 for every $100,000 invested in that fund. In 2014, the TSP charged investment fees of 0.029 percent, or $29 per $100,000 invested in the TSP.
Investing in the TSP compared to paying the average mutual fund fees resulted in a savings of $1,161 per $100,000 invested, every year. These savings compound over time, putting more money in your pocket each year.
Need more convincing? The mutual fund company Vanguard published a table that shows how paying an extra 1 percent in investment fees each year can erode more than 25 percent of your investment portfolio value over 30 years. It can be difficult to believe that saving only 1 percent in fees each year can have such a massive impact on your investment portfolio, but it’s true!
Earlier access to your money. The IRS may charge early withdrawal penalties to withdrawals made from retirement accounts before age 59 and a half. One exception is for the Separation from Service exemption. This rule allows TSP participants to make penalty-free withdrawals as early as age 55 if they retire from military or government service at age 55 or older. This exemption may not be available if you transfer your funds to another retirement account.
Simplicity and account consolidation. The TSP is easy to understand and manage. Many TSP participants decide to transfer funds from other 401k plans or IRAs into their TSP account to simplify their investment portfolio and take advantage of the benefits the TSP offers.
In general, it’s a good idea to leave your investments in the Thrift Savings Plan unless you have a compelling reason to move them into a new retirement account. Let’s take a look at some of those times when it makes sense to consider transferring your retirement funds.
When to Consider Transferring Your TSP Investments to Another Retirement Plan
Every investor has different needs. Below are a few times when you may wish to transfer your TSP investments into another retirement account. To avoid expensive mistakes, be sure to research your options before taking action. You may find it helpful to hire a tax professional or financial advisor if you have questions.
Consider transferring your TSP funds:
When you have advanced planning needs. Some people require assistance from a financial advisor, tax professional or estate planner. If you use a financial advisor, make sure he or she acts as a fiduciary, which means they act in your best interests. Be sure to understand how your financial advisor receives compensation to avoid conflicts of interest that may arise from working with a commission-based advisor who is compensated based on sales.
To avoid taking Required Minimum Distributions from Roth accounts. Participants in the Roth TSP are required to begin taking Required Minimum Distributions (RMD) beginning at age 70 and a half. However, there is no RMD requirement for Roth IRAs. You can avoid the RMD requirement by transferring your Roth TSP into a Roth IRA, allowing you to make withdrawals when you want or need them.
When you want to transfer tax-exempt contributions out of the TSP and into a Roth IRA. Some TSP members made tax-exempt contributions into a traditional account. This is common for TSP participants who made contributions while deployed to a tax-free combat zone (especially if they participated in the TSP before the Roth TSP was available).
These tax-exempt contributions will not be taxed upon withdrawal. However, their earnings will be taxed. Withdrawals are made on a pro-rata basis with traditional withdrawals. There is currently no way to separate those funds within the TSP. The only way to avoid paying taxes on the gains from the tax-exempt contributions is to roll those funds into a retirement account that accepts tax-exempt contributions, or to roll them into a Roth IRA where future gains and withdrawals will be tax free. Avoiding future taxes can save you a lot of money, so it is worth looking into transferring your funds. But a mistake could prove costly, so be sure to transfer your tax-exempt funds correctly.
When you want more investment options. You can have a well-diversified investment portfolio using only the funds found within the TSP, but many investors want different investment options. Transferring funds to another retirement account makes this easier.
When you want steady cash flow. Many retirees appreciate being able to trade some or all of their TSP investments for monthly payments. This can be done through an annuity. Some annuities can be complex and expensive, but the TSP offers a simple and low-cost annuity option that may be good for TSP participants who wish to convert their TSP savings into an income stream.
Steps to Take Before Transferring Any Funds In or Out of the TSP
Transferring funds in or out of your TSP can have a long-term impact on your financial well-being. In many cases, the actions you take are permanent and may have significant tax consequences. Take your time to understand all aspects of your situation before taking action. If needed, seek the advice of an investment or tax professional. They may be able to help you avoid expensive mistakes.
You also want to avoid cashing out your TSP unless you absolutely need immediate access to the funds. Doing so could subject you to immediate taxes and, depending on your age, early withdrawal penalties.
My final word of advice: Be sure to interview financial advisors before you hire one. It is appropriate and expected to ask how the advisor is compensated. Understanding how your advisor is compensated can help you identify potential conflicts of interest.
About the author: Ryan Guina is a military Veteran, small business owner and current member of the Air National Guard. He writes for RothIRA.com, TraditionalIRA.com and several other popular online publications.